Wednesday, February 13, 2013

Tax Theft 8

This entire series, beginning here, has discussed how different kinds of tax exemptions are used to force non-exempt taxpayers to subsidize exempt taxpayers. Some business deductions were discussed in Part 5, where we looked primarily at commercial loan deductions. All business deductions, though, are structured to use the resources of almost all taxpayers to subsidize the businesses of very few taxpayers. Many liberals and progressives will complain about "corporate welfare," in terms of direct corporate tax breaks and government investment in corporations, and that's certainly a large part of the picture, but the yearly, un-debated, shadow world of business deductions, with over a hundred years of history taking it off the public negotiation table, is far more powerful.

Business deductions operate on the obvious, completely fair rationalization that, if it costs you money to make money, you shouldn't have to pay income taxes on the part you didn't get to keep. That rationalization is then twisted like an ugly mutant, and used to justify certain deductions while not justifying others, resulting in the body politic picking up the tab for big business investment. Here's an example:

Cameron's Example

Cameron Peabody inherits $3.6 million from his grandmother (his sisters and his brother inherit similar amounts). Cameron decides that he's ready to stop fooling around with his life, and starts a construction company. After a lot of deliberation and planning meetings, he decides to name his company Peabody Construction, Inc. His lawyer, accountant, and business manager help him set everything up, and he hires some experienced builders to get his name out there with local subcontractors.

When his father sends him to meet the city manager, Cameron is nervous, but he remembers to maintain eye contact and be clear about what he wants--and to his surprise, the meeting goes well. He wins the bidding to have Peabody Construction construct the parking lots, restroom facilities, equipment sheds, bleachers, field and field lights for the new baseball park.

To get all this work done, Cameron's accountant takes some of the advance funds from the city and begins taking bids from subcontractors to do the work on the ground. Cameron, though, wants to have his own people do the parking lot, so he needs a couple backhoes, a couple scrapers, a resurfacer, and at least one cement truck. He buys them all at a cost of $800,000, and the work gets done.

When the last square of astroturf is cut and fitted, everyone in town is happy. A plaque by the home team dugout thanks Cameron Peabody of Peabody Construction for his contributions to the community, and local elementary schools name drinking fountains after Cameron. It's been a tough year, but after paying all of his subcontractors, and paying his own employee salaries, Cameron has an income of $1.6 million.

With the highest portion of it bracketed at a 39.6% rate, that means he should be paying income tax of $533,349.00. He didn't have to pay any taxes on the amount he inherited; he didn't have to pay anything for all of those lunches and builder's conventions the mayor took him to; he didn't have to pay any taxes on the community goodwill he inherited from his father's connections. We're focusing only on that year's "earned" income (heehee--ftw, Cameron!).

So, $533,349.00 in income tax, paid to the IRS that year for Cameron, right? That extra $533,349.00 is needed to pay for wars, roads, urban development councils, bailouts, and other stuff, right?

No, because of Cameron's other business deductions. Cameron had to spend $800,000 on those big construction vehicles, and he gets to take 100% equipment deductions, so his income goes down to $800,000, from $1.6 million. His tax drops to $253,349. He saved $280,000--hurrah for Cameron!

But Cameron isn't done. It cost him $112,000 to operate those big vehicles this year, with fuel and repair costs, so his income drops to $688,000. Tax drops to $214,149. Double hurrah! And licensing and insuring those expensive pieces of equipment doesn't come cheap, either: it costs around $30,000, so his income drops to $658,000, and his final tax due is $203,649.00.

Oops--we're still not done. Peabody Construction, Inc. paid for Cameron to attend an expensive builder's conference in Manhattan, and a commercial negotiation seminar at a pricey lodge in the Hamptons, which is a must for anyone serious about understanding zoning regulations while trying to manage a serious regional construction office. Cameron brought along his intern, Veronica, to help him present a professional image during the dinners and meetings, so he had to pay for her, too. After covering all the room fees, restaurant bills, day trips and speaker fees, his income is down to $594,000, and his tax at $181,249.

Frank's Example

Frank always knew he wanted to be a doctor, but when his girlfriend got pregnant, he had to find insurance, and jobs are supposed to have insurance. The one he got, working on a construction crew, didn't offer insurance as a direct benefit, but he could get it if he deducted about half his paycheck, so he did that.

In order to work at Peabody Construction, Inc., Frank has a problem: he can't work from home, so he has to drive to the job site every day. It changes a lot--Peabody does work all over town. And the "parking" at the job site is usually on a pothole-strewn hill covered with old nails and chunks of loose concrete. So Frank buys a used work truck for $26,499 from Peabody Ford (owned by Cameron's brother, Bryce Peabody), and he goes to work. He's required to buy a hard hat, a hard hat with an affixed light, and three bright orange safety aprons in order to be licensed by the general contractor, and if he doesn't wear coveralls, steel-toed boots, and bring lunch in an un-crushable cooler, he literally can't function on the job site. If he wants to get a job next year, he absolutely has to network with his co-workers and the site foreman at the Gully Bottom Grill three or four nights a week, or else they'll call him a sissy and he'll be replaced next year.

At the end of the year, pulling his share of 60 hour weeks, Frank has collected wages and overtime in the amount of $53,000, more than he ever hoped. After a standard deduction, he's liable for about $6,800 in taxes.

That's a tough pill to swallow, considering that Frank has $417.00 in his bank account, and he doesn't feel $53,000 richer. But then he comes up with an incredible idea: deductions! Frank realizes that he spent $26,499 on a work truck, and around $1,200 on equipment that he uses 100% at job-sites. To keep his shoulder and back from acting up, and to hedge against future problems, he bought medical insurance for his body, which took $3K from his paycheck. Without his wife helping get his lunches together, answer calls from supervisors while he was driving to and from job sites, and coordinate his shifting overtime schedule, Frank would be ruined, but he didn't pay her a salary, so he can't deduct that. He did, though, buy her health insurance for another $3K.

Frank's income is already down to $19,301, which means income tax of $998.00. Hurray, right? It gets even better, though: all of that networking that Frank did at the Gully Bottom Grill cost him about $800 worth of tequila, tips, and mozzarella sticks, so his income is down to $18,501, for tax due of $878. He already had way more than that deducted from his paycheck, so he should be eligible for a refund!

Unfortunately, we probably see where this is going: none of Frank's deductions count. Frank is still liable for $6,843 in taxes. (Oh, and that's federal. Frank will owe more to his state.)

Why and Why Not?

So, Cameron gets to deduct almost anything, and Frank gets to deduct almost nothing. Cameron can deduct 100% of work-related equipment, but Frank gets to deduct 0% of it. Why? The rationale goes, "Cameron bought his backhoe only for use in construction, while Frank bought his truck for both construction and personal use." No Franks get around that one, even if Frank can prove that his truck was used 100% of the time for driving to work or work-related events. Even if we take out the Gully Bottom Grill entirely, and Frank gives up future jobs just to get the truck deduction for one year, he still doesn't win. The IRS favors Cameron, every year, taking it for granted that Frank's truck is in a completely different class than Cameron's trucks.

Frank's other work gear, too, suffers this fate: no deduction. Cameron's three business cell phones are deductible, but Frank's one cell phone is not. Cameron's trips to New York are deductible, but Frank's trips to the Gully Bottom Grill are not. Cameron's liability and theft insurance is deductible, but Frank's is not. Even when Cameron insures his backhoes--necessary equipment for the construction company--it is deductible, while Frank's insurance for his own body--100% necessary for Frank to work--is not. This abjectly ludicrous theme holds true across the board: the government claims that all of Frank's expenses have a "personal use" aspect, while almost all of Cameron's expenses, however personal, can be tabulated to Cameron's business.

At finer levels of inquiry, this can be connected to a feudal style of property-preference: it is assumed that everyone decent has at least one phone, car, and vacation for personal use. Cameron doesn't get to deduct his first phone line, car, and vacation, and neither does Frank. But Cameron gets to deduct everything above and beyond that. All his extras are subsidized by the tax base, e.g., people who cannot afford extra assets are taxed in order to help pay for others' extra assets.

How many Franks does it take to cover Cameron's deductions? About 52. 52 Franks will pay the tax bill that makes up for the deductions of one Cameron. Not coincidentally, this is about how many employees Peabody Construction, Inc. has: 52 for each owner/investor. Bigger companies increase that proportion, so that enough "income" passes to employees to cover the boss' expenses.